Markets in trouble? Throw money at the problem. Lots of it

You know it's serious when central bankers, the people supposed to be cool in a crisis, panic. That is what seemed to happen yesterday as cheap money - billions upon billions of it - was pumped into the global banking system.

The result was another day of confusion, losses and knee-jerk responses. The FTSE 100 index lost £63bn or 233 points, the biggest fall since March 2003, when the last dotcom bubble burst.

Markets in Asia had dived in similar fashion. The Nikkei index in Japan was down 2.4%, while losses in Hong Kong were almost 3%. Only the American markets seemed able to resist. In mid-afternoon trading, the Dow Jones index was 1% lower, a relative triumph.

Are we facing a financial crisis to match the madness of that era, and the seriousness of the post 9/11 days? The European Central Bank seems to think so. Yesterday's helping of cheap money for the markets was €61bn (about £41bn), on top of €94bn on Thursday. Only one reading is possible: Frankfurt's bankers have decreed that the system has become so paralysed that only vast amounts of oil can get it moving. The US Federal Reserve, the chairman of the central bankers' club, seemed to agree. It pushed another $19bn (£9.4bn) into its markets, making $323bn over 48 hours.

At the Bank of England, there was no drama. Money is always on standby, it said, but it saw no reason to make it available at bargain rates. It clearly guards its reputation for staying calm.

Geoffrey Wood, professor of economics at Cass business school and special adviser on financial stability to the Bank of England, thinks the other banks are simply making the situation worse. "The ECB have acted rashly," he said.

The professor's view is that normal Darwinian economics are in action. Bad investment decisions are being punished, and the worst decision was the issue of mortgages to millions of Americans who couldn't service their debts - the so-called sub-prime loans, the toxic waste that is washing up on banks' books across the world.

If the problem seems remote, even containable, perhaps you haven't kept pace with financial innovation? A US mortgage is not just a home loan these days: it is a basis on which investment banks can build any number of financial assets as derivatives.

But risky products, dangerous bets and financial fashions have always been around. What's new this time?

"We have had this sort of thing since 1850," says Prof Wood. "As long as central banks have remained calm, there hasn't been a problem. All that has happened is that some people have made stupid investments. Others have made investments that looked sensible at the time, but turned out to be wrong."

The stupid are admitting to their mistakes daily, and they are not the crowd you might expect. Deutsche Bank, a pillar of the German banking system, said it had suffered falls of 30% in one fund.

That followed Thursdays's revelation by BNP Paribas, France's biggest bank, that it couldn't put a fair value on three of its hedge funds, as nobody was buying or selling so there were no prices. But BNP did not ease the liquidity problem: it said investors would not be able to cash out at this tricky time.

BNP's warning appeared to trigger the ECB's action, and the fear in the markets is that we have only seen the start of the story. Big banks can withstand some hits, but lower down the financial ladder suspicion is falling on hedge funds, some of whom have had huge appetites for assets backed by US mortgages.

For now, the worry is enough, which is why intervention by central banks is a double-edged sword. What aren't the bankers telling us? And what happens if the medicine doesn't work?

The cheery thought is this: behind the drama lies a fundamentally healthy global economy that has enjoyed an unbroken period of growth for decades. Most of us define a real financial crisis as a recession. We're not there yet.